.

-
inlormation supplied to it is reliable and accurate. The Internal controls are exercised to Ieiprnsl Contrnl
UNIT 2 INTERNAL CONTROL ensure accuracy and reliability of accounting data arrd other records, to identifi weaker
areas of operation and to jinzprove ttzenz, to irzcrease operatiortal eficiency of the
business, to safeguard its assets and to ensure orderly corzduct o j busirless.
Structure The American Institute of Public Accountants has defined Internal Control as "The plan
2.0 Objectives of organisation and all the coordinate methods, and measures adopted within a business
2. i Introduction to safegudrd its assets, check the accuracy and thc reliability of its accounting data,
promote operational efficiency and encourage adlierence to prescribed managerial
2.2 Internal Conlrol
2.2.1 Objecdves of Internal Corltrol policies. A system of Intei-nal Control extends heyond those matters which relale directly
2.2.2 Forms of Internal Control to the functions of the accounting and financial departments".
2.2.3 Internal Control and Auditor The Institute of' Chartered Accountants of England and Wales defines internal control as
2.2.4 Requisites of a Good Internal Control System "Internal Control means not only internal check or internal audit, but the wl~olesystem
2.3 Internal Audit 'of control, financial and otherwise, established by management in order to carry on the
2.3.1 Objecthes of Internal Audit
2.3.2 Internal Audit vs. Slatutory Audit
business of the company in'an orderly manner, salcguard its assets and secure as far as
2.4 Internal Check possible accuracy and reliability of its records".
2.4.1 Objectives of Internal Check If we analyse the above definitions it would be cvide~ltthat internal control is a broad
2.4.2 Essentials of a Good Internal Check System term with a wide coverage. It consists of a number of checks and controls which are
2.4.3 Internal Chcck as regards Cash Sales exercised in a business to ensure its efficient and economic working. Thus, internal
2.4.4 Internal check as regards Purchases control involves a sort of vigilance attd direction over inlpnrtant matters, like budget
2.4.5 Internal check as regards Sales
and finance, purcheses and sales and internal adoiinistration by the managenrent.
2.4.6 Internal Check as regards Wage Payment
2,4.7 Internal Check System and Auditor Every business e~iteiyriseis expected to devise a suitable system of internal control in
2.5 Let Us Sum Up order to carry on the business in an efficient and orderly manner. These controls are
2.6 Key Words accounting control, standwd cost control, budgetary control, statistical analysis and
2.7 ~ n s w e r sto Check Your Progress internal checks and internal audit. In simple words, it means number of checks and
2.8 Tewinal Questions controls over the various activities of n business. Generally, a system of internal control
will include all those measures which assist a business enterprise to fulfil the following
2.0 OBJECTIVES I objectives.

h.2.1 Objectives of Internal Control

After studying this unit, you should be able to :
r explain the meaning and objectives of internal control
a enumerate the features of a good internal control
distinguish between internal audit and statutory audit
o describe the meaning and objectives of internal check system
a devise the system of internal check with regard to cash sales, credit sales, wages
and salaries, purchases, stock, etc.
e explain the duty of the auditor in regard to internal check.
2.1 INTRODUCTION
--
In Unit 1 you have learnt the concept of auditing, different classes of audit and modes
of audit, Another important nrca is internal control, Internal control refers a number of
checks and controls exercised in a business to ensure its efficiel~tand economic
working. In this unit you will learn the ineaning and objectives.of internal control and
internal check. You will also learn various system of internal check.
--
2.2 INTERNAL C.ONTROL
Internal control is an important tool'of management. It assists the management in the
qerformance of its various functions. It means the built in cross-checks in the systems
supplemented with priper supervision and internal audit carried out by the staff
appointed by the organisation. Tliese days business has become more complex both in
natuie and size, the management finds it difficult to get correct information about the
.various aspects of tlie business. Internal control assures the, management that the
1 To minimise, if not completely eliminate, wastages and inefficiencies in business
operations and to safeguard the assets of the business.
2 To ensure high degree of accuracy and reliability of accounting data and promote
I operational efficiency.
3 To measure how far the policies of the management are being implemented, and
4 Ta ovaluate the efficiency of performance in all aspects of business activities and
to highlight the weaknesses,
r'
2.22 Forms of Internal Control
t
I
'3 F~msof Internal Control holps in ensuring correct and reliable records of transactions
I
and operational sfflciencies,'let us discuss them in detail.
I
1 A~gountingControls : It ensures correct and reliable records of transactions in
conformity with normally accepted accounting principles. Such controls comprise
primarily the plan of organization and the procedures and records that nre
concerned with and directly related to the safeguarding of assets and liabilities of
.financial records. Accounting the finuncial controls include budgetary controls,
standard cost control, self-balancing ledgers, bank recdnciliation, and internal
checks and internal auditing, Accounting controls have a direct and significant
bearing on the work of an accountant. These controls deal with the process of
recording of tr;?nsactions, safeguarding the assets and adherence to prescribed
managerial policies.
2 + Administrative Controls : ~ h scope
z of this control is very wide. They also
include accounting controls. Such controls con~priseof the plan of organization
that are concel-ned mainly with 'operational efficiencies. In short, they may include
'
anything from plan of organisation to procedures, record keeping, distribution of
'
authority and the process of decision-making. They include controls viz. time and
'

,motion studies, quality contro1,through inspection, statistical analysis and

Fundamentals of Auditing performance .evaluation, etc. An auditor should make a careful review of
accounting controls as they have a direct bearing on the reliability of the financial
statements. He may, also, evaluate those administrative controls which have direct
bearing on the financial statements. He is primarily concerned with the accounting
controls.
2.2.3 Internal Control and Auditor
The position of the auditor regarding internal control has been stated in the slatements
on Auditing practices issued by the Institute of Chartered Accountants of India which
says "the duty of safeguarding the assets of a Company is primarily that of
management, and the auditor is entitled to rely upon the safeguards and internal cont;.ols
instituted by the management, although he will take into account the deficiencies, he
may note therein while drafting his audit programme". It clearly means that an auditor is
concerned only wit11 the evaluation of the intel.na1 control to know its strength ,and
weaknesses. In case he finds that the internal control system is inadequate, he should
then plan to carry out detailed examination of tliose areas where the system is weak. It
is therefore necessary for the auditor to acquaint himself fully .with the internal control
, in force and their actual operation. It will help him in the formulation of his audit
programme. He may also bring the shortcomings of the internal control system to the
notice of the management.
2.2.4 Requisites of a Good Internal Control System
.The following,are the essential requisites of a good Internal Control System:
1 A well-developed plan of orgnisation with proper delegation of functional
responsibilities should be devised. No internal control system can be effective
without such plan of organisation.
2 A scientific system of authorisation and record procedures should be developed
with a view to provide proper coiltrol over assets, liabilities, revenues and
expenses of the organisation. It sllould be developed in such a fashion as to ensure
that (a) assets are kept under proper custody and they are not improperly applied,
(b) expenditures are incurred on getting proper authorisation and revenues received
are duly accounted for.
3 A system of healthy practices and traditions should be developed with a view ta
discharge the duties and functions of the various departments of the organisation
smoothly.
4 Since internal control system is to be exercised by the personnel employed in the
organisation, there should be a team of people with sound character and integrity
who are properly trained and capable of discharging their responsibilities.
5 Constant managerial supervision and periodical review of the system should be
introduced with a view to make the system more efficient and effective.
Check bur Progress A
1 Define internal control.
2 Distinguish between accountancy control a'nd administrative control.
3 State whether each of the following is True or Fa!se :
i) Inlernal control is different f ~ o minternal.
ii) Internal control 'does not include accounting control.
iii) Internal control is compulsory in all business organizations.
iv) Internal control includes quality control and time and motioil studies.
v) An effective internal control system helps external auditor to design suitable
audit progranune for client's organization.
.. vi) Internal control is a tool in the hands of an external auditor to improve the
recording of the business transactions.
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2.3 INTERNAL AUDIT
Internal audit is described as the verification of the operations and transactions within
a
the business by a specially assigned staff. It is an important tool of nlanagement to
evaluate the coiiectness of records on a continuous basis in an organization.
The term internal audit has been defined as "an independcnt appraisal of activity within
an organisntion for review of accounting, financial and other opcrations as a basis of
service lo management. It is Inanagerial conlrol which functions by ~neasuringand '
evaluating the effectiveness of other controls".
According to Howard F Stettler, "Internal auditing is an independcnt appraisal activity
within an organisation for the review of operations as a service to managemenl".
The overall objective of internal auditing, therefore, is to assist the managemFnt in the
effectivc discl~argeof their responsibilities by furnishing them with objkctive analysis,
a 1 appraisals, recorhmondations and pertinent comments concerning the activities reviewed.
I d short, internal audit assures t l ~ erna!aageme!zt that the system of iirtertial clzeck and
other types of controts are effective in desigtz and operation.
Thus, internal audit is a thorough examination of the accou~itingtransactions
that -
LO e
3sure
i) the transactions are properly recorded.
I
ii) the accounts fire mainlained systematica\ly, and
iii) there is no possibility for ~nanipulationof accounts or misappropriation of property
,' of the business,
In modern times, an internal auditor carries a new task. The traditional function of ,
checking the arithmetical correctness of the accounts with t.he help of voucllers and ,
documents and verification of few items such as. stock, cash and fixed assets i s not
i' sufficient. The duty of internal auditor now is to chart the procedures, examine their
efficiency and work on programmes of improvement of assessing the effectiveness of
controls. He is expected to plan and arrange his task for effective functioning, set clear
objectives of his own section, phase his objectives, gain the confidence of the
management and demonstrate the value of his functions in areas of performance.
Thc internal audit is carried out generally in the s ~ m manner
e as is followed for a
professional audit. However, it varies in f o ~ mfrom enterprise to enterprise according to
its size and specific needs. It is installed in large organisation and is carried ol;'t by the
I salaried stage who are qualified to conduct professional audit. Being the employee of the
organization, he has to ensure that there is no waste in the organization. Internal auditor
1, has to follow the provisions of law, standard auditing practices and procedures-
prescribed for professional auditors and by the professional bodies controlling the audit
system in the country. At the same time, internal auditor must be aware. of the policies
\ and programmes of the enterprise. He should be professionally competent to carry out a
I detailed examination of working of the business. Equipped with professional expertise
and knowledge of the business, he will be in better position to make the internal audit
1
b
system more effective. .
!
~undainlntnliof Auditing 2.3.1 Objectives of Inlteraral Audit ,
Internal Control
InternaI Audit Statutory Audit 1. pi
The main objectives of internal audit can thus be stated as under :
1 To verify the correctness and authenticity of the financial records and statistical 1 Internal audit is the arrangement Statutory audit is the examination of the
records presented to the management. within the organisation to verify books of accounts of the business by an
on continuous basis the correctness external auditor and to report that the Profit
2 To ensure that the standard accounting practices are strictly followed in the and truthness and truthfulness of
,
organization. and Loss Account and Balance Sheet are
the transactions by the salaried off. drawn according to provisions of law and the
3 To facilitate early detection of errors and frauds. financial statements reveal the true and fair
To ensure that all transactions have been carried out under a proper authority and view of the results of operations and financial
4
by persons authorised for the same in the business. state of affairs of the business.
2 Internal audit is not compulsory Statutory audit is. compulsory in case of
5 To review the system of internal check from time to time, to advise the
management on improvement of the system and to undertake special investigation business houses incorporated under the
for the management. Companies AcVand other Acts.
' 3 Internal audit is carried out by ~ t a t u t o audit
j can be canied out dnly by
6 To confirm that the liabilities have been incurred by the organization for legitimate
the staff appointed by the those who are qualified for appointment as
activities.
business enterprise. It is not per the provisions of the Companies Act and
necessary that the internal other Acts.
Thus, efficiency of internal audit depends on the efficiency of the staff employed for the audit staff should possess the
purpose. Internal audit can be effective on1y if the interpal auditor is given wider' qualification prescribed for
authority to investigate the transactions not only from financial angles but also from professional auditor.
other organisational activities. Internal auditor should report directly to the top
management. He must operate independently of the accounting and other staff. He must 4 Being an employee of the The rights, duties, responsibilities and
I

be given an'independent status as an important functionary and a part of the organisation internal auditor is liabilities of auditors are governed by the
management. answerable to the management. provisions of law. An auditor is independent
His duties, reponsibilities etc. of management.
regarding audit work are
2.3.2 Internal Audit vs. Statutory Audit determined by the management.
Internal audit helps the statutory audit to' a large extent. Both the internal auditor and The management can increase the
powers and authority of the
the statutory auditor have a common interest as far as authenticity of the accounts are
concerned. However, the soundness of internal audit relieves the statutory auditor from internal auditor. Similarly, it
can also curtail lfis powers.
detailed checking.
5 The internal auditor points out The statutory auditor is concerned with the
The internal auditor reviews the operations and performs such functions as evaluation, irregularities in the procedural legality and validity of the transactions of
compliance, verification and ensures that policies, procedures, rules and other types of aspects and suggests the ways business. His audit work is ,based on the
controls of the.business are carried out efficiently. and means to rectify !he same. financial statement prepared by the business.
He assures that the financial
He is helpful to statutory'auditor in the matter of examination of the books of accounts.
operations and other types of
Generally, thp statutory auditor accepts some of the detailed ~heckingmade by internal
control in-force are carried out
auditor. Hovieler, the area of cooperation between internal auditor and statutory auditor
in conformity with the accounting
is somewhit limited as'the statutory auditor has a responsibility under law to variobs
authorities, while the internal auditor is .responsible only to the management. The systems.
statutory auditor cannot get any protection against liability for negligence. The statutory
auditor has to cany out his duties in accordance with standard accounting and auditing
practice and rovisions of law which govern the organisations. Before accepting the
Check Your Progress B
$
checking of accounts and other documents carried to by internal auditor, the statutory
1 What do you mean by internal audit.
auditor must undertake" such test checks necessary to find out the effectiveness of
internal audit.

But internal auditor and statutory auditor carry out examination of records and
documents-and make physical and other verifications. Despite these similarities, there are

and statutory auditor.

Difference between Internal Audit and Statutory Audit

2 Write two points of differences between inic;nal audit and statutory audit.
The following are the points of difference between internal audit and statutory
 .
~undhmeritalsof Auditing 3 Fill in the blanks with appropriate word given in the bracket. I .

' 2.4.1 Objectives of Internal Check

i) Internal audit .....................1 .................(compulsoiylnot compulsory)
ii) Internal audit ............................. the statutory audit. (helpskampers).
iii) The main objective of internal audit is to .................. early detection of
errors and frauds. (facilitieskampers).
iv) Statutory audit is ......................;. in case of business houses incorporated
under the companies act and other act. (cornpulsory/not compulsory).
4 State whether each of the following statements are True or False :
i) Internnl audit is compulsory in big organisation,
1 To reduce the chance of frauds and errors that inay be con~rnittcdby any member
of the staff and make it more difficult. If any fraud is to be committed two or
more persons must collude together.
2 To detect fraud and errors easily and correct them promptly.
3 To exercise moral pressure among the me~nbersof the slaff.
-
4 To allocale duties and responsibilities of every person in such a way that 11e can
be taken into task for any lapse on his part.
5 To increase overall efficiency of the members of the staff by assigning duties
based on the principle of division of labour.

ii)
iii)
Statutory audit is compulsory in a Joint Stock Company.
Internal auditor must be a chartered accountant.
I 6 To have an accurate and reliable record of all business transactions.

iv) Internal auditor is appojnted as per the procedure laid down on the ! 2.4.2 Essentials of a Good Internal Check System
companies act. 1 The following essential points must be kept in view at the time of installing tile system ,'

Statutory audit can not be started unless internal audit is complete in a

i of interrlal check :
v)
company. 1 . No single staff member shall have absolute control over recording of all the
aspecls of business transactions by himself.
vi) Duties and rights of a statutory auditor are determined by the management of
the company. 2 The sane staff shall not be allowed to have access to all books of accounts as
well as physical custbdy of the assets.
vii) Statutory auditor is' a permanent employee of the organisation.
3 Each member of the staff should be made responsible for a specific work.
viii) Internal audit and internal check cannot be installed in a partnership
4 All officials and e~nployeesholding responsibility towards cash, securities or stock
busjness.
should be encouraged to proceed on annual leave to prevent the concealed fraud.

2.4 INTERNAL CHECK I1 5

Internal check is a system enforced in business under which the recording of business
transactions is mr'mged in such a manner that the work of one staff member will
automatically be checked by others in the course of recording of the transaction itself.
Spicer and Pegler have defined a system of internnl check as "an arrangement of staff
duties where by no one pcrsclti is3allowed to carry tlirough and record every aspect of a
transaction so that, without collusio~~ between two or more persons, fraud is prevented
and at the same tirne, Lhe possibilities of errors are reduced to a minimum". "Practically
De Paula has defined internal check as a continuous internal audit carried on by the
staff itself by means of which the work of each individual is independently checked by
other members of the staff."
Thus, under internal check system the staff duties are so arranged that IIO one person is
allowed to record every aspect of the transactions and the entire work is dlohbuted
amongst the various members of the staff in such a manner that the work of one person
is automatically checked by others. The essential elements of inte~nalcheck are as
follows:
1 Existence of checks on the day-to-day transactions.
2 The check'is to be carried out continuously as a part of the routine system.
3 The work is divided among the staff and each staff is assigned a specific task.
4 The work of each staff, though independent, is complementary to the w~rlcof
6
'The duties of the members of the staff should be changed from time to time.
.Attempts should be made to introduce mechanical devices to prevent
. misappropriation of cash.
7 Each transaction should pass through a definite route and several hands.
8 A11 books, vouchers, documents should be classified and made available for easy
reference.
9 Proper record must be maintained of the incoming and out-going of goods from
' the.business premises.
10 Self-balancing ledger system should be introduced to make the system more
4
efficient and effective.
t-
11 No undue importance should be given to any staff member and too much reliance
I on any staff member should be avoided.
12 Division and allocntion of duties among the staff members must provide for an
automatic check by others.
2.4.3 Internal Check as Regards Cash Sales
ince chances of committing fraud in connection with cash sales are greater, i t calls for
evising an efficient and effective system of internal check. Cash sales may be effected
in various ways like (a) Sales at counter, (b) Postal sales i.e., Sales under Mail Order,
. and (c) Sales by representatives and agents. The system of internal check to be followed
in each case is discussed below.

Cash Sales Effected at Sales Counters

The system of internal check is increasingly recognised by the auditor specially when
the size of the concern is large. The existence of effective internal check system relieves The following steps in the system of internal check are suggested : ,
the external auditor of detailed checking to a larger extent. The extent to which an
I

external auditor can depend upon the system of internal check is based on the
1 One salesman must be appointed to look after one counter independently and ',I
I

should be made responsible for sales effected in his counter.

procedural tests applied by hiin to find out the effectiveness of the system. However, the ......
2. Each salesman must be issued with a separate cash memo or sales memo book. , ., .
a~lditorcan not be relieved of his responsibility if he was found guilty of negligence ;, '\
regardless of the fact that'he. had tested the internal check in existence in the The cash memo books may be printed in.different colours to identify different ,
' organization before he had accepted it as correct. ' . counters
. of the business. , 27 , ..
 Fundamer~talsof Auditing
,
3 Each salesman must maintain a sales sheet. He should record therein the sales
effected by him. The summary of cash sales effected by him must tally with the
cash memos issued by him.
4 Cash memo are to be issued with carbon copies.
5 The salesman must not receive cash on the cash rnemos issued by him.'
6 All payments on the cash memo of the salesman must be made by the customer at
the cash' counter.
7 Sales are to be effected in the following manner :
i) Three copies of cash memos must be issued to customer.
ii) The customer must pr'esent the three copies of each memo to the casluer at
the time of making payment. . ,
iii) The cashier must verify the particulars and satisfy himself regarding the total
payment with reference to rates and quantity.
iv) The cashier on receiving the payment in cash will place a rubber stamp on
all the copies of cash memos as "cash paid".
v) He will retain one copy with himself and hand over two other copies to the
customer.
vi) The customer must present the cash inemos to the delivery department to
collect the goods purchased.
vii) The delivery department will put rubber stamp on the memos as "goods
delivered". He will retain one copy as an evidence for delivery and hand
over another copy of the memo to the customer.
At the end of day's working, the salesmen, the cashier and the gate-keeper should
prepare the summary and submit to the manager or officer-in-charge, If these summaries
tally, the accounts are certified as correct.
Postal Sales i.e., Sales under Mail Order
This includes following aspects.
1
All sales made by post i.e., V.P.P. should be recorded in a separate register to be
maintained for the purpose.
2 The goods returned, if any, should be recorded in the register.
3 The total amount of cash receipts including advance, if my against the mail orders
should be entered in the register and the same should be deposited into the bank.
4 A11 the entries in the V.P.P. register should be checked by some responsible officer
and special enquiries should be made in respect of those goods against which can
not been received.
5 There should be proper filing of maiI orders.
Cash Sales by Representative and Agents
It is the practice in big business houses to employ representatives and agents to promote
sales and to collect the amount due from debtors. The system of internal check to be .
introduced in this connection should be as follows :
1 The representatives and agents should be authorised to issue rough receipts to the
customers against cash received from them. However, the final receipt should be
issued only by the head ~ffice.
2 The customers should be advised to communicate directly with the head office if
they do not get the final receipt within a reasonable time period.
3 The representatives and agents should be instructed to remit the amount of cash
collected by them to the head office without any delay.
, 9 . The purchase department should make an endorseme~ltputting rubber stamp on the
4 The representatives and agents must not be allowed under any circumstances to
deduct their commission or any other expenditure from the amount of cash
28 . 10
collected by them. The bill for commission and other expenses should be a
submitted to the head office. t*
Internal Control
5 As a matter of routine, the head office should sei~dperiodical statements of
accounts Lo the custo~nerswith a view to apprise them of the latest position.
6 The representatives and agents should be advised to subinit periodical statements
to the head office showing therein the amount of sales made by them, the amount
of cash collected by them and the names of the defaulters.
7 The head office should issue reminders to those defaulting customers who have
failed to clear their dues.
8 The representatives and agents must not be allowed to operate from a fixed place.
.On the contrary, they should be transferred from time to time to other place in
order to increase their efficiency and to avoid the possibility of committing fraud.
2.4.4 Internal Check as Regards Purchases
Since chances of committing fraud in coilnection with the purchases of goods by a big
business house are greater, .it calls for dcvicing an efficient and effective control system
1 of internal check. In this connection, one should be familiar with the.purchases
procedure which should be as under :
1 The department requiring the material should rill in the purchase requisition
indicating the quantity and quality to the purchase depqrttnent.
2 The purchase department on the basis of he requisitio~lwill send out enquiries to
the various suppliers aski~lgfor quotation.
3 On receipt of quotations, the order will b& placed on thc best vendor taking into
accouril: the qudity, period of delivery, competitive prices etc.
4 Qn receiving the order, the vendor shall execute the order. The supplies will be
received by the storm department.
5 On receipt of goods, it will he verified with reference to the order with the goods
received memo issued by the stores department. If the supplies are made according
to the order the delivery note and invoice sent by the supplier will be forwarded to
accounts department with endorselnents for the goods received and taken to stores.
6 h he voice will be passed for payment by a senior officer after verifying the terms
and conditions of the supply with reference to rates and quantity and other
expenses detailed in it.
Keeping the above points in.view, the following system of internal check is suggested
., with reguds to purchases:
1 khkre should be separate purchase department.
2 Purchase order are to be issued only against indents received from the various
departments of the business.
3 All prders should be placed in writing, The order forms must be preferably a
printed form containing full details.
4 The orders must be made in quadruplicate. One copy ol the order is to be sent to
the supplier. The second copy is to be sent to the concerned depdment which has
placed the indent for supply; third copy is to be sent to accounts department and
the fourth copy is to be retained by the purchase department for future reference.
5 All orders for purchases should be signed only by the purchase manager or the
person authorised for this purpose.
6 All orders should contain the seal of office.
7 The goods received should be inspected with the copy of the order.
8 The goods received are to be examined with delivery notes and supply invoices of
the seller regard%g quantity, quality and rates.
suppliers bill with reference to goods received.
After inspection and exanination of 'Goods Received Note' is to be prepared for
each lot of purchase. The inspection note should also be attached to it.
 Intcrnal Control
!t I*litltlroc.u~cnt
r11~1:,1bc 111adcby the purchase lnanager or the authorised official to 3 Roper record is to be maintained for the orders received, order under execution/.
\,rclrci d~.l~;~rll~~er~t
[(I take the goods illto stock. executed/refused.
I? "I tic, l,10rc4 ~lt'~)ilrtll~cnt
should acknowledge receipt of goods and send the s a n e to 4 The sales shall be authorised by responsible officials after scrutiny of the order
t h t . t~hJcr(Icpi~rt~~~er~l.
and assessing the portion of supply of goods as well as the terms and conditions
Ii . ? inco~rlinggoods are to bc opened only in the presence of a
Ail I I : I & * ~ ; I ~ ~11f of sales accepted by the customer.
tcyior~\it~lc c\f(icinl. 5 All sales orders shall contain invoices prepared in quadruplicate. One copy is to be
111 "t'hc- \tnrcs off~ccron verification of the correctness of the goods received should retained by the sales department, one to be sellt to the customer, one to the
c11tc.r.rhrsrn in the stock reg~ster. accounts department and the last copy to despatch section for despatch of goods.
15 Iit2mr;~l1y;t rnt)ber stnnip containing the Following certificate will be placed on the 6 Scparate departments should deal with cash sales and credit sales.
ru~q~licr:;
hill i111dsigned by the purchase manager. In the case of credit sales a separate register should be maintained of the
7
"l'c~litictlthnt potrds are received as per order No. ......... ...... Dated ...... . .. and customers with financial standing. The credit sale is to be allowed only after
tahelr (11 stock vide folio No. .........,..... of stock register No. ............... . 37 scrutinv of the customer's order for supply of goods on credit.
I6 'I'he p.lyrncnt on pinchases must be mide only after accounts department verifies 8 Periodical statement of the outstanding balance due towards the customer be sent
thc invoice, goods received note and purchase order. and confirmation obtained from them.
17 "l'he accounts tlepnrtrtlent should impress a rubber stamp on invoices which are 9 Regular reminders for payment shall be made to the customers reminding them of
p;lwztl For priymcnts. their dues.
1S :
IscI~iUilttpurchnsc register is to be maintained by the purchase department. 10 Amount due from the customer shall not be written off as bad unless all methods
1" II,cdpcrclerk should have no access to physical stock register or cash to avoid of recovery are exhausted.
nranipulntion of accounts. 11 The respo.sible official shall be entitled to treat a debt as bad.
2 F:or inter-branull purchases or inter-company purchases transfer notes should be 12 The sales invoice clerk shall have no access to physical stock or accounting
ivsoetl, records.
21 All p ~ r c h i a ct l~~ i ~;re
t made by employee for the penonal use must be accounted The credit note shall be prepared only after ascertaining the fact from the despatch
13
ti rr separately.
--
>7
A rcpsriite rcturn outward book is to be maintained to record the return of goods
to sup[)liers.
section and the sales department for the goods received back from the customers.
Credit notes are to be' prepared in quadruplicate. One is to b e retained with the
invoice department, second copy is t o be sent to despatch department, third copy
21 Credit notes are to be issued for adjusting claims. The purcha~edepartment should to [he sales department and fourth copy to the customer.
send :I copy of credit note to accounts depnrtment. 14 In case sales are cancelled, a notice is to be given to the despatcb department to
14 A purcht~eledger control accounts is to be contained. Ledger accounts should be stop -
* despatch of goods.
checked periodically i~gainstthe suppliers statements. 15 The, invoices can be cancelled only by the sales department. All sales invoices
25 A i"rpetua1 inv~lltorycontrol method should be adopted to avoid excess quantity must be printed and numbered in serial order.
to 111ilintai11111inim11mquantity, 16 The sales ledger shall be maintained by a separate clerk.
"1 Where are delivered directly to locations or place of work not controlled by 17 Periodical statements should be sent to debtors.
tile ~urch:lse department, th invoices arc to be passed by the purchase d ~ p a r m e n t
{ I ~ I J Yilftcr cxanlining the certificate of receipt of stock from the authority to whom 18 In the case of credit sales regular confirnation should be obtained from the
the gorrds are delivered. customers regarding the outstanding balances. The confirmation of balances must
be'verified by a senior person other than the ledger clerk.
In .!Xmeral the purchase departncnt nlust he place purchase orders on the basis of
Jn(l~nts9rei.ord (1s ~)rdenin the purchase or book, enter the goods received in the goods 19 A sales ledger control account shall b e balanced with the control account
l o w a ~ hook l and send the invoice of the supplier alongwith the inspection report and periodically.'
~ ( l ( d . ' i received nolts to the accounts department for payment,
20 A sales ledger control account in the general ledger shall be maintained.
above will avoid irregularities in purchase and minimi=, if
mcmal check 3s sugge~t~d
21 Credit to employee's can be allowed only after proper authorization from the
not ~ ( ) m ~ l eeliminate,
bl~ manipulation of accounts by entering fictitious purchase or
cntcring invoice twice or mis-appropriating the discount or commission allowed by the management .
suppliers. 22 Separate department should be set up to deal with sales on consignment, hire
purchase, goods on sales or return.
2.4.5 lnternal Check as Regards Sales The stock held by the agents should be verified periodically with the statements
23
*flXOr~aniwtionof' the sales department depends on the system of received from the agents.
ilinributlon .f p o ~ d Unless
~. the depxtment is 0rganised proprly there areand
greater The goods sent on sale or return basis but unsold on the date of the balance sleet
.,.
Ws~hllltlcsfor suppressian of sales and manipulation of accounu. ~~~d~ can also be
24
should not b e treated as sales but unsold stock.
mi*ik~'~r~~rifltcd,
Wn.ccW ~ ~ 1 1 - k nsystem
it of internal check is necessary
in the foilawing manner : Internal check system with regard to cash received on sales is suggested under the
may be
1 c q l i v n "cash sales". The internal check of the sales depart~nentincludes the
Sales 1nUrt he e ~ e c ~ t eoginst
d order received from customers, I

suggesi~,tis, given for internal check on cash sales.

9
* All inconling orders shall be numbered,and filled and c o n f h a i o n the
~ " i v c d bc sent to the customers. .
Funda~nentalsof Auditing
2.4.6 internal Check as Regards Wage Payment
In big organization, the work regarding the maintenance of various type of wage
records. computing the amount of wages and the paynlcnl of wages to the right persons
are of significant importance. It is, ll~erefore,necessaly to design a proper system of
internal check regarding wages payments to minimize the dangdk of fictitious names,
errors in wage records and misappropriation of money. The following system of internal
check is suggested:
1 Workers should be employed only after the writLen order of the Person~~el Officer
or the appointing authority. A copy of the appointment order be endorsed to the .
wage preparing section.
2 Separate staff should record attendance of workers, control of leave, payment of
ovefiime and disbursement of pay packets. Each staff member shall be responsible
to enter relevant information in the wage sheet. He should also put initials for the
work completed by him.
3 The wage sheel shall contain columns for recording relevant informations with
regard to payment of wages rucl~as name of the employee, designation, period for
whicll wages are paid, rate of pay, amount of basic pay, dearness allowance,
house rent a ~ h w ~ ccon-qensatory
e, allowance and other allowance, gross salary
drawn, deductions (there should be separate columns indicating the nature of
deductions) and net amount payable and signature of employees, for
acknowledging the payment.
4 Separate records should be maintained for each worker indicming the date of
appointment, scale of pay, rate of pay, etc. Copies or orders relating to increase in
Pay* promotions and punishments, deduction in wages on account of provident
Fund, Loan, Medical, Group Insurance etc. shall be endorsed to wage preparing
section,
5 Separate job cards are to be mainlained for recording tile work performed by the
worker.
6 Each worker is to be given a pay slip indicating the gross wages a~ldnet wages.
7 Separate register is to be maintained for recording the name of workers who may
be allowed to work overtime. No worker shall be allowed to work overtime
without the prior sanction of the proper authority.
8 Time recording clocks sllall be installed at the main gate of the factory for
recording the arrival and departure of workers.
9 The roasters of work for each work should be prepared and a copy of the same be
sent to the wage preparing section.
10 . Late arrivals of the workers shall be entered in a separate register and the same
will be seat to the personnel section for future refereoce.
11 Proper watch and ward arrangement is to be maintained to record the arrival of
the worken and the time of leaving the factory.
12 The rate'of wage of each worker is to be periodically cllecked with reference to
rate cards.
13 All calculations regarding gross wages and net wages payable after deduction are
Lo be checked by an independent person.
14 In the wage sheet, the names of workers, rates of pay, the period for which wages
is to be paid shall be entered by one person. The calculations regarding gross
wages ~ayableshall be made by another person. The deductions under various
heads shall be made by a third person. The net wages payable and the checking
of the wage sheet with reference to leave deductions, etc. should be made by a '
senior staff member. The wage sheet shall be signed by the authorised official.
15 If the wages are to be paid on the basis of piece &age system, the actual work
done by each worker must be maintained on a job card to be given to each
worker. These cards should be counter signed by the foreman of the department
and the store department to which the goods produced are delivered.
Internal Contra1
16 The wage sheet shall be prepared in triplicate. One copy shall be endorsed to pay
master: the second copy to tho account section and the final copy shall be retaimd
bv
-,the wage- preparing
- . sectioll. .-
The payment of wages to the workers is done by the cashier as he is not associated witb
the preparation of the wages sheets. Cashier should withdraw the net amount as shown
by the wage sheets. The payment of wage will be made in the presence of a responsible
official such as the foreman of the section to identify the workers taking their pay
packets. Every month the payment will be made on a fixed date and time. Payment
made under left hand thumb impression will be witnessed by the forernnn of the
department. Over time wages and incentives shall be prepared in separate wage sheets.
A statement of u$aid wages will also be prepared by the cashier and sent to the pay
drawing authority for information. If the wages are claimed subsequently, it requires an
s~lthorisationfor payment from pay drawing authority.
The internal check with regard to preparation of wages sheets involves an elaborate
system of preparing and checking of wage sheets and the calculation regarding ihe
wages payable on the basis of time and piece wage records.
2.4.7 Internal Check System and Auditor
The soundness of the system of internal check and the way it is put into operation in
the organisation are matter of great importance for the auditor. In case the system of
internal check is effective the work of the external auditor becomes quite easy. He is
relieved of the detailed and routine checking of the transactions as the internal check
system takes care of the same. In case, the internal check system is not effective, then
the auditor will have to decide the extent of detailed checking to be undertaken in order
to satisfy himself about the authenticity of the business records. It is therefore, necesswy
for the auditor to audy the system in force is weak or defective, then he should c q
out detailed checking of the accounting records. In case, he does not do so, he may be
held liable for all the undetected errors and frauds. He should not show any negligence '
in his duty. He should design the audit programme keeping in view the weak links' of
the system. He should, also suggest the changes to the management snengthening tho
,system of internal check. It should be note: that the.existence of a sound internal check
rvstem
-, ,in an organization helps the auditor to a great extent in audit work, but docs not
~
.. ,
reduce his legal-liability at all.
Check Your Progress C
1 w h i t do you mean by internal check?
.................................................................
.....................................
........................................................................................................
.,.,,~.,.i,...,.,..............,,,,.?...,,.,,...,~,,...........,..................~4..........-..,.....'
,
2 List three internal checks as regards sales.
......................................................................................................
,.,..,...",..,..............,,,,,,,.,....,.,....,....................~...............~~~.~...~.~......
3 . State whether each of tho statement is True or False :
lnternal check i$ based on the principle of division of labour.
ii) Internal check system eliminates errors and frauds.
is) An effective internal check system of an organization reduces the liability of
an external auditor as far as the audited accounts of the organization are
concerned.
*
iv) Internal heck can not be introduced in tho organization without first
installing internal audit.
 Internal Contl
Fundamentals of Auditing '

2.5 LET US SUM UP 1 . ~ ~Cl~eck

~ ~ : It
~ is1 an arrangement of staff duties whereby no one penon is allowed
m ,any through and to record every aspect of a transaction so that fraud is prevented
Internal control is a broad term with a wide coverage. 1 consists of a number of checks and at the same time, the possibilities of errors are reduced to a minimum.
and controls which are exercised in a business to ensure its efficient and economic
working. It ertends beyond those rnattcrs which related directly to the functions of the
accounting and financial shternents. Internal controls are of two forms-Accounting 2.7 ANSWERS TO CHECK YOUR PROGRESS
controls and Adminislrative Controls.
A 3 (i) True, (ii) False, (iii) False. (iv) True. (v) True1 (vi) False
Objectives of internal control are: (i).to mini~nisewastages and in efficiencies (ii) to
safeguard assets (iii) to ensure high degree of accuracy and reliability of accounting data B 3 (i) ~ o compulsory,
t (ii) Helps, (iii) ~ a c i l t i e s , (iv) C ~ m ~ u l s o r ~
(iv) to prornote operational efficiency (v) to measure effectiveness of managenlent policy 4 (i) Fnlse, (ii) True, (iii) False, (iv) False, (v) False. (vi) False, (vii) False.
(vi) to evaluate the efficiency of performance and (vii) to highlight the weaknesses.
(viii) False
An auditor is concerned only with the evaluation of the system of internal control to (ii) False. (iii) False, (iv) True
C 3 (i) True,
know its strength and weaknesses. In case, he finds that the system of internal control is
inadequate, he should taken plan to cany out detailed examination.
Requisites of a good internal control system are: (i) a well developed plan of
organisation, (ii) a scientific system of authorisation and record procedures,
(iii) a system of healthy practices and traditions, (iv) a team of people with sound .
character and integrity and (v) constant inanagerial supervision and periodicnl review are the requisites of a good internal control system?
of the system.
-7 What is meant by the tern "Internal Check"? TO what extent an auditor can rely
Internal audit is an independent appraisal of activity within an organisation for review on this? Explain with examples.
accounting financial and other operations as a basis of service to management. It is a
3 between Internal Audit and Statutory Audit. c a n the statutory audjtor
managerial control which functions by measuring and evaluating the effectiveness of
other controls. Statutory audit, on the other hand, is an examination of the books of . the internal audit in carrying out.hb
relv, upon .: functions as SQtUtory audifor?
accounts by an external auditor and to report lhat the Profit & Loss Account and the 4 ' What is meant by "Internal Audit'? What ar': its objectives?
Balance Sheet, are drawn in accordance with the provision of law and the financial
statements reveal the true and fair view of the results of operations and financial state Explain clearly h e diffemncc between "Internal check" and "Inlernal Audit"?
affairs of the business. 5 Ouiline the purpose and major characteristics of a s o u ~ ~system
d of internal control.
Internal check is an arrangement of staff duties whereby no one person is allowed to As an auditor how would you determine the effectiveness of such a system?
carry though and to record every aspect of a transaction so that, witl~outcollusion 6 Suggest n suitable system of internal check for cash sales in a big departmental
between two or more persons, fraud is prevented and at the same time, b e possibilities store.
of errors are reduced to a minimum,
7 Devise a suitable system of internal check in respect of wage payment for a large .
Objectives of internal check system are (i) to reduce the chances of frauds and errors manufacturing concern.
(ii) to detect frauds and errors easily (iii) to exercise moral pressure among member of
the staff (iv) to allocate duties and responsibilities of every person in such a way that h e Outline a system of internal check in respect of purchases.
can be taken to tasks for any lapse on his pan (v) to increase overall efficiency of
members of the staff and (vi) to have accurate and reliable record.
Note': These questions will help you to understand the unit better. Try to write
Suitable internal check syslem c a n be devised for specific items like cash sales, credit answers for them. But do not submit your answers to the University. Thesc
sales, purchases, wages payment etc. with a view to minimise the possibilities of fraud. are for your practice only.
r 1 1
However, it is important to note here that existence of a sound internal check Eystem in
an organisation helps the auditor to a great extent in the discharge of his duties, but it
cannot reduce his liabilities at all.

2.6 KEY WORDS

Internal Control : It is the whole system of controls official and otherwise established :
by the management in the conduct of a business, including internal check, internal audit .
and other forms of control.
Accounting Control : It ensures correct and reliable record of transactions in confomity
with norn~allyaccepted acco'unting principles. -
Administrative Control : It comprises of the plan of organisation which is mainly
concerned with operatioqal efficiencies. I t includes time and motion studia, quality
control statistical analysis and perfomlance evaluation.
Internal Audit : It is an independent appraisal of activity wiUlin an organisation of
review of accounting, financial and ojher operations as a basis of service to
management. a

34